In this article:
- How Does a Five-Year CD Work?
- Pros and Cons of Five-Year CDs
- Is a Five-year CD a Good Investment?
- Alternatives to Five-Year CDs
A five-year certificate of deposit (CD) might be a good investment if stable, predictable gains sound appealing. A five-year CD allows you to grow your savings at a guaranteed rate, but potential for gains aren't as high as riskier investments. With interest rates at a relative high, now may be a good time to consider putting some of your cash into a five-year CD.
Then again, a five-year CD might not be right for every investor. Here's what to know about five-year CDs, including how they work, when they work best and what some of your alternatives might be.
How Does a Five-Year CD Work?
A CD is like a savings account, but it requires you to leave your money in place for a specified time. In exchange, you receive a predetermined amount of interest, or yield. Interest is paid periodically throughout the CD's term. Your money is typically insured and, unlike stock investments, isn't subject to market volatility.
At the end of the term, you receive your principal back plus interest, which you can roll into a new CD or invest elsewhere as you'd like.
Here are a few additional rules that distinguish CDs from regular savings accounts:
- CDs require an upfront deposit. Although some CDs allow you to add money during the term, typically CDs are opened with a lump sum.
- Early withdrawals are subject to penalty. These penalties vary, but could amount to a year's worth of interest on a five-year CD, payable even if you haven't kept the money in your account long enough to accrue enough interest to cover the fee. CDs work best for money you don't mind tying up for the duration of the CD's term.
- CDs typically pay higher interest rates than traditional savings accounts. High-yield CDs have even higher annual percentage yields (APYs).
- CDs pay a consistent rate of return. The rate on a regular savings account typically changes as the Federal Reserve adjusts the fed rate. The yield on a CD does not fluctuate.
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Pros and Cons of Five-Year CDs
Like any investment, five-year CDs have pros and cons to consider. Here are a few of the most common arguments for and against.
Pros
- High rates: According to Fed data, the average interest rate on five-year CDs was three times the average rate on traditional savings in October 2023, 1.38% versus 0.46%. High-yield CDs have even higher rates, with available rates topping 5%. CD interest rates are also up compared with rates from a few years ago: The average five-year CD rate in October 2021 was 0.27%.
- Low risk: Other than early withdrawal penalties, you can't really lose money with a CD. As long as your CD is kept at an FDIC-insured bank or NCUA-insured credit union, your money is protected in the unlikely event of a closure.
- No volatility: The value of your CD doesn't dip below the amount you've deposited. Additionally, your interest rate doesn't decline over the course of your CD's term.
Cons
- Less flexibility: If you decide your money is better off invested elsewhere before the five-year term is up, you'll forfeit some of your interest as an early withdrawal penalty.
- Less accessibility: Early withdrawal penalties also apply if you need access to your funds early. For this reason, CDs aren't ideal for emergency savings.
- Limited upside: Although rates are relatively high in 2023, they could go even higher in the years to come. If you're locked into a five-year term, you may not be able to capitalize on an interest rate increase. Long-term investors may also want to accept more risk in exchange for more aggressive growth. The Standard & Poor's (S&P) 500 stock index averaged 9.82% in annual returns between 1928 and 2022, though with plenty of ups, downs and potential losses. Maximizing your gains could help your portfolio better keep pace with inflation.
- A long term: While it may be reassuring to know how much your money will earn for the next five years, some 12-month CDs currently have even higher rates than their five-year counterparts—and a shorter time commitment.
Is a Five-year CD a Good Investment?
A five-year CD is a low-risk investment with predictable returns and a significantly higher yield than traditional savings. When interest rates are high, a five-year CD allows you to lock in an attractive rate for a relatively long time.
A five-year CD might fit you and your investment goals if the following descriptions sound familiar:
- You need to mitigate risk. Nobody likes losing money, but some people have good reason to be risk-averse. Maybe you already have investments in a brokerage account; now you're looking for some stability to balance them out. Maybe you're nearing retirement (or are already retired) and you feel you can't afford to lose money because you don't have time to recoup it.
- You think rates will drop. If interest rates continue to trend upward, having your money locked into a five-year CD won't be an advantage. But if rates go down, you might be happy to have your money earn current rates over the long term.
A five-year CD might not be the best investment if you need to maximize returns (regardless of risk), or if you think you'll need the money before the term expires. If you aren't sure whether a five-year CD—or any investment—is right for you, take a closer look at your overall financial picture, consider your options and get help from a trusted advisor if you can.
Alternatives to Five-Year CDs
Here are a few alternatives to check out if you're not sure a five-year CD is the right vehicle for you.
High-Yield Savings Accounts
Although the yield on a five-year CD often beats the APY on a high-yield savings account, the main trade-off is flexibility. There's no required term on high-yield savings: You can withdraw or deposit money at will. On the downside, if interest rates drop, the APY on a high-yield savings account will likely drop with it.
Money Market Accounts
Money market accounts offer higher interest rates than regular savings accounts, plus limited checks or debit transactions. Because they're a good place to earn interest on savings and pay bills in a pinch, money market accounts can be a good place to store emergency savings.
Series I Bonds
Series I savings bonds, issued by the U.S. Department of Treasury, pay an interest rate that's indexed to inflation. Series I bonds mature in 30 years, but you can sell a Series I bond on the secondary market after 12 months. Be aware, however, that if you sell it before five years have passed, you'll have to forfeit three months' worth of interest.
Treasury Notes
Treasury notes are also backed by the full faith and credit of the U.S. government. As of this writing, interest rates on five-year CDs and five-year Treasury notes are comparable. Buying, holding and selling T-notes can be more complicated than opening a CD, so be prepared to do a little research if you decide to go this way. Learn more about five-year Treasury notes at Treasury Direct.
The Bottom Line
With interest rates at a relative high, five-year CDs may be an appealing option for investors who need a stable, low-risk investment over the medium term. CDs are also widely available and easy to open, which makes them accessible to do-it-yourself investors.
Before you open a five-year CD, take the time to research the best available rates and terms. Yields can vary quite a bit from bank to bank (or credit union). Fees and penalties can also vary, so shop around for the best deal. Also, consider how a five-year CD fits into your overall saving and investing strategy, balancing stability against risk and growth.
